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Related party Transactions under Companies Act, 2013
Before we move the discussion further, we should know the meaning of term "Related Party".
Related party with reference to a company has been defined by sec 2(76) the Act, which includes the following.
- Director or his relative
- Key Managerial Person his relative
- Firm in which director, manager or their relative is a partner
- Any Private Company in which director or manager is a member or director
- Public company in which director is a director or holds along with his relatives more than 2% of paid up share capital
- A body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager
- Any person on whose advice director or manager is accustomed to act except in a professional capacity
- Any company which is-
- A holding , subsidiary or an associate company of such company; or
- A subsidiary of a holding company to which it is also a subsidiary;
- Such other person as may be prescribed.
Contract with Related Parties are, most of the times, are viewed with suspicion, as it is presumed that these contracts are entered with the related parties just to divert the funds of the companies or to pass on the undue benefits to the relatives or entities owned or controlled by the promoters or directors of the companies or their relatives. Actually, in case of family controlled businesses, transactions with related parties became very easy as there was virtually no control on the functioning of these companies. Though, these companies used public funds by way of short term loans by way of working capital and long term funds from Banks and other Institutions, but they were not supposed to appoint any nominee director or independent Director. Further, these companies were also not required to subject to any disclosure requirements stipulated by SEBI or any Stock Exchange.
But, Companies Act, 2013, though on the one hand dispenses with the govt approvals as laid down in the Section 297 of the 1956 Act and gives autonomy to the Board and Shareholders of the Companies to approve related party transactions, but on the other hand it prescribes onerous responsibilities and imposes stringent penalties on the Directors, including Independent Directors, if the transactions with related parties are not on arms length basis.
This major change in law of doing away with the bureaucratic approvals simply suggests that the existing system of approval did not yield the desired results and the transactions with related parties went on abated. The new changes favour self regulations, disclosures, transparency but with strict penalties in case of violation of law.
Section-184 (Disclosure of interest by director)
Disclosure of interest by a director has been made mandatory. This disclosure is to be given by the directornat the first Board Meeting which he attends after his appointment and subsequently in every first meeting of the Board in each financial year.
Further, this disclosure is also to be given before any proposed contract is entered into with any related party. Any violation of the provisions of this Section by any director shall make him liable for imprisonment up to one year.
Section-188 (Related Party Transactions)
Section 188 of the new Companies Act, which specifically deals with Related party Transactions, can be said to be a Combination of Sections 294, 297 and 314 of the 1956 Act.
Under section 297 of the Companies Act, 1956, a director of the company or his relative, a firm in which such a director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director shall not enter into any contract with the company unless the consent of board of directors is received for the following transactions:-
- For the sale, purchase or supply of any goods, materials or services; or
- For underwriting the subscription of any shares or debentures of the company:
Besides that in case of company having paid–up capital of not less than Rs. One Crore, previous approval of central government is also required along with the consent of Board of Directors.
Section 188, the transaction area has been widened with a relaxation that there is no need to take the previous approval of central government even in the case of companies having paid-up capital more than One Crore. The new Act has also introduced the requirement of resolutions to be passed in favour of transactions by shareholders only, if the transaction amount is beyond a particular threshold limit.
Clause188 has taken in its ambit some more transactions which are as follows:-
- Sale , purchase or supply of any goods or materials
- Selling or otherwise disposing of , or buying property of any kind
- Leasing of property of any kind
- Appointment of any agents for purchase or sale of goods, materials, services or property
- such related party's appointment to any office or place of profit in the company, its subsidiary company or associate company; and
- underwriting the subscription of any securities or derivatives thereof, of the company:
Clause 188 does not apply to any transactions if :
- the transaction is in the ordinary course of business; and
- is at arm’s length price.
The term arm’s length has been defined in the Act to mean a transaction between related parties, which is conducted as if they were unrelated so that there is no conflict of interest.
Section 188 further provides that no member of the company shall vote on such special resolution to approve any contract or arrangement which may be entered into by the company, if such member is a related party. It means that only unrelated or disinterested shareholders only can vote on a Special Resolution.
Every contract or arrangement entered into under this shall be referred
to in the Board’s report to the shareholders along with the justification for entering into such contract or arrangement
Any such contract or arrangement shall be voidable at the option of the Board if such contract or arrangement is entered into without obtaining the consent of the Board or approval by a special resolution, as the case may be. Further, the directors concerned shall indemnify the company against any loss incurred by it.
Penalties
Any director who had entered into any contract or arrangement in violation of the provisions of this section shall,—
(i). in case of listed company, be punishable with imprisonment for a term which
may extend to one year or with fine which shall not be less than twenty-five thousand
rupees but which may extend to five lakh rupees, or with both; and
(ii). in case of any other company, be punishable with fine which shall not be less
than twenty-five thousand rupees but which may extend to five lakh rupees.
Disqualification
Section 164 states that a person shall not be eligible for appointment as a director of a company, if he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years.
Treatment of Related Party Transactions under Income Tax, 1961
Like the Companies Act, Income Tax Act also prescribes some provisions under which a disclosure that a related party transactions was made during the year has to be disclosed.
Section 40a(2)(b) of the Income Tax Act disallows the expenditure incurred in relation with specified persons (Related Parties), if assessing officer is in the opinion that the expenditure is excessive & unreasonable with respect to fair market value of goods, services or facilities used.
Code for Independent Directors and Related Party Transaction
Last but not the least, Schedule IV of the Act, which prescribes Code for Independent Directors states that it shall be the duty of Independent Directors to pay sufficient attention and ensure that adequate deliberations are held before approving related party transactions and assure themselves that the same are in the interest of the company.
At the end, we can say that though these self regulatory provisions may seem to be simple, but actually they cast upon a greater responsibility on the directors, employees and shareholders of the companies. |